IFRS 9 Financial Instruments - v2

Financial
Instruments
IFRS 9 and IAS 32
©2022 Grant Thornton Bharat LLP. All rights reserved.

Agenda
01 02
Scope Definitions
03 04
Liabilities vs. Equity Classification &
Measurement
05
06
Prepayment Features
with Negative Derivatives and
Compensation Embedded
derivatives
07 08
De-recognition
Impairment of
09 Financial Assets
Hedge Accounting 10
11 Interest Rate
BPP Question Practice Benchmark Reform
2 ©2022 Grant Thornton Bharat LLP. All rights reserved.
Scope
3
Content
IAS 32 – Presentation of Financial Instruments
IFRS 9 - Financial Instruments – effective for periods beginning on or after 1 January

2018.
❑ Recognition and derecognition of all financial assets and financial liabilities
❑ Impairment of financial assets
❑ Criteria for hedge accounting
IFRS 7 – Disclosure of Financial Instruments

Scope
Applicable to all type of financial instruments except:
Interest in Subsidiary, Associate and Joint venture (IFRS 10 and

IAS 28)
Contracts for contingent consideration in business combinations

(IFRS 3)
Employees rights and obligation (IAS 19)
Financial instruments, contracts and obligations under share-

based payment transactions (IFRS 2)

Definitions
6
Definition – Financial Instrument
Financial asset
of one entity
FINANCIAL
INSTRUMENT
Financial
liability or
equity
instrument of
another entity

Definition – Financial Asset
Financial asset is
• cash
• an equity instrument of another entity
• a contractual right:
• to receive cash or another financial asset from another entity
• to exchange financial assets or financial liabilities under favourable conditions
• a contract that will or may be settled in the entity's own equity instruments and is
• a non-derivative for which the entity is or may be obliged to receive a variable number of the entity's own equity instruments; or
• a derivative that will or may be settled other than by the exchange of a fixed amount of cash or another financial asset for a fixed
number of the entity's own equity instruments (See further for examples)

Definition – Financial Liability
Financial liability is
• A contractual obligation
• to deliver cash or other financial assets to another entity
• to exchange financial assets/ liabilities under potentially unfavourable conditions; or
• a contract that will or may be settled in the entity’s own equity instruments and is:
• a non-derivative for which the entity is or may be obliged to deliver a variable number of the entity’s own equity instruments; or
• a derivative that will or may be settled other than by the exchange of a fixed amount of cash or another financial asset for a
fixed number of the entity’s own equity instruments
(See further for examples)

Financial Instruments in Financial Statements?
Sr. No. SOFP item Is it a financial Coverage under IAS Coverage under
Instrument? 32 and IFRS 7 IFRS 9
1 Intangible asset No NA NA
2 PPE No NA NA
3 Investment Property No NA NA
4 Interest in subsidiaries, associates and joint venture

accounted for as per IFRS 10, IAS 28 and IFRS 11 Yes NA NA
5 Assets held for sale accounted for as per IFRS 5 No NA NA
6 Interest in subsidiaries, associates and joint venture Yes Yes Yes

accounted for IFRS 9
7 Inventories No NA NA
8 CWIP No NA NA

Financial Instruments in Financial Statements?
Sr. No. SOFP item Is it a financial Coverage under IAS Coverage under
Instrument? 32 and IFRS 7 IFRS 9
9 Construction contract receivables Yes Yes Yes
10 Finance Lease receivables Yes NA NA
11 Trade receivables Yes Yes Yes
12 Pre-payments - Goods and services No NA NA
13 Cash and cash equivalent Yes Yes Yes
14 Trade payables Yes Yes Yes
15 Accruals- goods and services Yes Yes Yes
16 Deferred Income (advance received) No NA NA

Transactions in Own Equity
Two most important things to watch out are:
▪ Are equity instruments own or issued by somebody else?
▪ Is the amount to deliver or exchange fixed or variable?
Examples:
1.You sell an option to deliver 100 shares of Apple to your friend.
This is a financial liability, because the shares are NOT YOUR OWN shares. They are shares of somebody else (Apple in this case).
2.You sell an option to deliver your own shares in total value of $100 to your friend.
This is a financial liability, too, because although the shares are yours, their number is variable. Why?
Because, the exact number of shares will depend on the current price of the share at the delivery. You will calculate it as 100 divided by the market
price of one share.
3.You sell an option to deliver 100 pieces of your own shares to your friend.
This is an equity instrument, because the shares are yours and their amount is fixed – 100.

Definition – Equity
Equity
Any contract that evidences a residual interest in net assets of an entity
Examples
– Ordinary shares
– Share warrants
– Mandatorily convertible preference shares
in other words, contracts that are not liabilities

Liabilities vs.
Equity
14
IAS 32 - Equity or Liability Distinction
Why does it matter?
Initial and subsequent

Presentation in statement of Treatment of payments,
measurement (scope of IFRS
financial position repurchases etc
9)

Equity and Liability Classification
Financial instrument is an equity instrument only if both criteria are met:
• There is no obligation to deliver cash or another financial asset or to exchange financial assets or financial liability; and
• The issuer will exchange fixed amount of cash or another financial asset for a fixed number of its own equity instruments.
Does the entity have an unavoidable contractual obligation?
Yes No
Liability Equity

Equity and Liability Classification
Features of a liability: Features of equity:
• Obligation to pay cash • Discretion over cash payments (i.e. no obligation)
• Mandatory redemption • Fixed amount of cash for a fixed amount of shares – the fixed-for-
fixed criteria
• Puttable instruments @ NAV
• Not dependent on:
• Only a conditional right to avoid
– Ability to make distributions
• Indirect obligation
– Intention to make distributions
• Settled in a variable number of shares
– Negative impact on ordinary shares
• Contingent settlement provisions
– Amount of issuer’s reserves
– Expectation of profits for the period

Examples
Type of instrument Liability Equity
Non-redeemable shares with discretionary dividends

('ordinary shares')
Shares that are redeemable at the option of the holder ('puttable shares')
Shares that are redeemable at the option of the issuer ('callable shares')
Irredeemable preference shares with contractual dividends payable @4% p.a.
Ordinary shares issued in a jurisdiction where company law requires companies to pay dividends of at
least 10% of profits

Compound Instruments
Compound instruments:
liability component
Instrument whose terms indicate
that it contains both a liability and
'split accounting'
an equity component
equity component
• must meet the definition of equity
• calculated as a residual

Example
Instrument Liability Component Equity Component
1) Preference shares with discretionary dividends Principal redemption liability Discretionary dividend
2) Convertible bonds Principal redemption and interest payment liability Convertibility option to the holder
Issuer of a non-derivative fin. instrument to evaluate the terms of the fin. instrument to determine whether it contains both a liability and an equity
component. If such components are identified, they must be accounted for separately as fin. liabilities, fin. assets or equity, and the liability and equity
components shown separately on the balance sheet.

Separation
Liability
Fair value using rate for non-convertible debt
Convertible Debt
+
Equity
Balancing Figure
The transaction costs are allocated to the liability and equity components in the same proportion as above.
Example
• ABC PLC issues 2,000 convertible bonds.
• The bonds have a 3 year term, and are issued at par with a face value of Rs.1,000 per bond, giving total proceeds of INR 2,000,000.
• Interest is payable annually in arrears at a nominal annual interest rate of 6% (i.e. INR.120,000 per annum).
• Each bond is convertible at any time up to maturity into 250 ordinary shares. When the bonds are issued, the prevailing market interest rate for
similar debt without conversion options is 9% per annum.
• The entity incurs issue costs of INR 100,000.
How should ABC PLC classify the bond?

Solution
Year Particulars Cash flow (INR) Discount Factor (@9%) NPV of cash flows
1 Interest 120,000 1/1.09 110,092
2 Interest 120,000 1/1.09^2 101,002
3 Interest & principal 2,120,000 1/1.09^3 1,637,029
Total liability component 1,848,122
Total equity component (balance) 151,878
Total proceeds 2,000,000

Solution (continued…)
• The issue cost Rs.100,000 would be allocated to the liability and equity components on a pro-rata basis i.e. Rs.92,406 (100,000 X 18,48,122 /
2,000,000) towards debt and; balance Rs.7,594 towards equity.
• Rs.144,284 (151,878 minus 7,594) credited to equity is not subsequently re-measured.
• On the assumption that the liability is not classified as at fair value through profit or loss the Rs.1,755,716 liability component would be accounted for
under the effective interest rate method.

Case Study- 1
Terms Classification
Redemption of Payment of Type of Reasons

principal dividends (assume instrument
all at market rates)
Non-redeemable Discretionary Equity There is no contractual obligation to pay cash. Any dividends
paid are recognised in Equity
Non-discretionary Liability Liability component is equal to the present value of the

dividend payments to perpetuity.
Assuming the dividends are set at market rates, the proceeds
will be equivalent to the fair
value (at the date of issue) of the dividends payable to
perpetuity.
Therefore, the entire proceeds are classified as a liability

Case Study- 2

Redeemable at the Discretionary Equity There is no contractual obligation to pay cash. An option to redeem
issuer’s option at the shares for cash does not satisfy the definition of a financial
some future date. liability. Any dividends paid are recognised in equity
Non-discretionary Liability with an Liability component equal to the present value of the dividend
embedded call payments to perpetuity.
option derivative Assuming the dividends are set at market rates, the proceeds will
be equivalent to the fair
value (at the date of issue) of the dividends payable to perpetuity.
Therefore, the entire proceeds are classified as a liability.
In addition, because the entire instrument is classified as a liability,
the issuer call option to
redeem the shares for cash is an embedded derivative (an asset).

Case Study- 3

Mandatorily Discretionary Compound Liability component is equal to the present value of the
redeemable at a redemption amount. Equity component is equal to proceeds
fixed or less liability component. Any
determinable dividends paid are related to the equity component and are
amount at a fixed or recognised in equity.
future date. If any unpaid dividends are added to the redemption amount,
then the whole instrument is a financial liability.
Non-discretionary Liability The entity has an obligation to pay cash in respect of both
principal and dividends

Case Study- 4

Redeemable at the Discretionary Compound Liability component is equal to the present value of the
holder’s option at redemption amount. Equity component is equal to proceeds
some future date. less liability component. Any
dividends paid are related to the equity component and are
recognised in equity.
If any unpaid dividends are added to the redemption amount,
then the whole instrument is a financial liability.
Non-discretionary Liability with an Dividend. In addition, because the entire instrument is

embedded put classified as a liability, the embedded put option to redeem the
option derivative shares for
cash is an embedded derivative.

Classification &
Measurement
29
Categories of Financial Assets – based on
Subsequent Measurement
1 2 2A 2B
Amortised Cost Fair Value Fair Value through Fair Value through
OCI P&L

Application to Investments in Debt Securities
Debt investments Derivative investments Equity investments
(A) Contractual cash flows solely payments of principal

and interest
Fail Fail Fail
Pass
Business model (BM) test Held for trading?

(B) (at entity level)
Hold to collect BM to collect Neither 1
1 2 contractual cash Yes No
contractual cash
flows and sell asset or 2
flows
Fair value option elected? FVOCI option

Yes No elected?
No No Yes
Amortised cost FVOCI (with FVPL FVOCI (no

recycling) recycling)

Application to Derivatives
Contractual cash flows solely payments of

principal and interest
Fail Fail Fail
Pass

(at entity level)
Hold to collect BM to collect Neither
1 2 contractual cash Yes No
contractual cash flows and sell 1 or 2
flows asset

Yes No elected?
No No Yes
Amortised cost FVOCI (with FVPL FVOCI
recycling) (no recycling)

Application to Equity Investments
Contractual cash flows solely payments of

principal and interest
Fail Fail Fail

Pass

(at entity level)
BM to collect Neither
1 Hold to collect 2 Yes No
contractual cash 1 or 2
contractual cash
flows and sell
flows
asset
Yes No elected?
No No Yes
Amortised FVOCI (with FVPL FVOCI

cost recycling) (no recycling)

'Hold to collect’ Business Model
Objective
• collect contractual payments over life of the instrument
• entity manages the assets held within the portfolio to collect those particular contractual cash flows
Frequency of sales in Value of sales in prior Timing of sales in prior Expectations about
Factors to consider Reason for such sales
prior periods periods periods future
Example
• policy to sell assets when there is an increase in the asset's credit risk or to manage credit concentration risk
• sales close to maturity of the assets where proceeds approximate remaining contractual cash flows
• increased sales in a particular period if the entity can explain the reasons for the sales

'Hold to collect’ Business Model
Example
Sales in a held-to-collect business model
Entity A has a portfolio of financial assets which is part of a held-to-collect business model. Due to change in legal requirement, entity A has to sell some
of the assets and has to significantly rebalance its portfolio.
Whether, business model needs to be assessed or changed ?
Solution
No, as the selling activity is considered an isolated or one-time event.
However, if the rules require entity A to routinely sell financial assets from its portfolio and the value of assets sold is significant, entity A's business model
would not be held-to-collect.

'Hold to collect and sell’ Business Model
(B-2)
• KMP's decision – both:
‒ collecting contractual cash flows and
‒ selling financial assets
are integral to achieving the objective of the business model
• compared to 'hold to collect' business model, this business model will typically involve greater frequency and value of sales
• no threshold for the frequency or value of sales
• Examples of objectives consistent with 'hold to collect and sell' business model:
‒ manage everyday liquidity needs
‒ maintain a particular interest yield profile
‒ match the duration of the financial assets to the duration of the liabilities that those assets are funding

Holding investments in anticipation of capital expenditure
Example
Entity A is planning a capital expenditure in five years. For funding the expansion, entity A invested, funds in financial assets. However the maturity of
financial assets does not match with the period of capital expenditure.
Entity A might hold the financial assets, till its maturity or will sell before maturity, if they fetch higher returns. Remuneration of the portfolio’s managers is
based on return from the assets.
Solution
Entity A’s objective for managing the financial assets is achieved by both collecting contractual cash flows and selling financial assets.

Example
Entity Z operates in the entertainment industry. Its operations include a sports stadium. Entity Z has a long-term plan for renovating the stadium involving
significant investment at set points three, seven and ten years in the future. In anticipation of this expenditure, Entity Z invests surplus cash in bond
assets. Many of the bonds have maturity dates that substantially exceed the points at which the stadium expenditure is expected to take place.
Solution
Entity Z holds these bonds to collect the contractual cash flows until it needs the cash to invest in the stadium. It may also make opportunistic sales if
management considers that market prices rise to levels that significantly exceed their own assessment of the bonds’ fundamental valuation. Accordingly
the bonds held by Entity Z would be accounted for under a hold to collect and sell business model.

'Other’ Business Models – The Residual
Category (B–3)
• Financial assets are measured at fair value through profit or loss if they are not held within a business model whose objective is:
‒ to hold assets to collect contractual cash flows, or
‒ achieved by both collecting contractual cash flows and selling financial assets
Example
− assets managed with the objective of realising cash flows through sale
− a portfolio that is managed, and whose performance is evaluated, on a fair value basis
− a portfolio that meets the definition of ‘held-for-trading’

Reassessment of Business Models
• An entity should reassess its business models at each reporting period.

• Reclassification of financial assets is required when, and only when, an entity changes its business model for managing the assets.
Scenario Change of
Scenario
business model?
Entity A holds a group of debt assets originally intending to collect all the contractual cash flows. As a result
of a cash shortage management decides to sell half the assets
Entity B holds a portfolio of debt assets for trading and classifies them at FVTPL. Due to a severe financial
crisis the market in these assets disappears.
Entity C is a financial services firm with a large retail domestic mortgage business. As a result of a strategic
review management decides to close this business and commences a Programme to sell the loans

'Solely payment of principal and interest'
('SPPI’) Test – (A)
• Contractual cash flows that are SPPI are consistent with a basic lending arrangement
• Principal is the fair value of the financial asset at initial recognition – principal amount may change over the life of the financial asset (for example,
if there are repayments of principal)
• Interest elements – consideration consistent with basic lending arrangement:

‒ time value of money
‒ credit risk
‒ other basic lending risks (example, liquidity risk)
‒ costs associated with holding the financial asset for a particular period of time
‒ profit margin that is consistent with a basic lending arrangement
• Assessment done in the currency in which financial asset is denominated

SPPI Test – Examples of terms inconsistent
with basic lending arrangement
Contractual terms that introduce exposure to risks or volatility in the contractual cash flows that is unrelated to a basic lending arrangement, such as
exposure to changes in equity prices or commodity prices
• Examples
(a) Interest rate is linked with equity index
(b) A simple loan Interest is linked with gold index
leverage increases the variability of the contractual cash flows with the result that they do not have the economic characteristics of interest.
• Examples
(a) Interest is leveraged – say 3 times of risk-free rate
(b) Indian loan interest rate is 5 times of EPS of the company

Consideration for Time Value of Money
Element of interest that provides consideration for

Time value of money only the passage of time
• in order to assess whether the element provides consideration for only the passage of time, an entity:
‒ applies judgment
‒ considers relevant factors such as
• currency in which the financial asset is denominated
• period for which the interest rate is set
‒ assesses nature of modification to time value of money element

Classification and Measurement Principles –
Financial liabilities
01 02
Amortised • Host instrument - Amortised cost,
cost
• Embedded derivative - fair value
• liabilities held for trading (includes all derivatives) are measured at fair value.
• financial liabilities at fair value through profit or loss. Such liabilities, including derivatives that are liabilities, shall be subsequently measured at fair
value.

Subsequent Measurement – Financial
liabilities
At fair value through Profit or

loss
Carried at fair value, changes taken to

income statement
Subsequent measurement - financial liabilities
Carried at amortised cost
Other Liabilities

Initial Measurement – Transaction costs
Financial assets To be added to the amount
originally recognised
Financial instruments
carried at other than
FVTPL
To be deducted from
Financial liabilities amount originally
recognised
Transaction costs
Financial instruments Immediately recognised in profit or loss on

Measured at FVTPL initial recognition
Transaction costs are incremental costs that are directly attributable to the acquisition or issue or disposal of a financial asset or financial liability.
Example of transaction cost are regulatory and registration fees, loan processing fees, brokerage, etc.
Note : Transaction costs expected to be incurred on a financial instrument's transfer or disposal are not included in the financial instrument's
measurement.

Solve: Transaction Costs
Example
XYZ purchases a financial asset for $1,000 which is classified as a financial asset at fair value through other comprehensive income.
Transaction costs of $20 were incurred on the purchase.
The asset is initially measured at $1,020.
Determine how XYZ recognise the above transaction?
Solution
If the asset had been classified as fair value through profit or loss it would be measured at $1,000 and the $20 would be expensed to profit or loss
immediately.

The Concept of Amortised Cost – Financial
assets
Amount cumulative
Amortised - Principal +/-
= initially amortisation - Impairment
cost repayments
recognised using EIR
Effective interest rate is the rate that exactly discounts the expected stream of future cash payments or receipts through maturity to the net
carrying amount at initial recognition.
No option to use straight line method

liability
Amount cumulative
Amortised Principal
cost = initially - repayments
+/- amortisation
recognised using EIR
Use effective interest rate method
No option to use straight line method

liability
Example
A company issues a $100,000 zero coupon bond redeemable in 5 years at $150,000.
The internal rate of return (the yield) on these flows is 8.45%.
Determine how entity will recognise the above transaction?
Solution
This should be used to allocate the expense.
Closing
Period Opening balance Interest
balance
8.45%
1 100,000 8,447 108,447
2 108,447 9,161 117,608
3 117,608 9,935 127,542
4 127,542 10,774 138,316
5 138,316 11,684 150,000

Prepayment
Features with
Negative
Compensation
51
Prepayment Features with Negative
Compensation
Applying the IFRS 9 requirements for recognising and measuring financial instruments to
certain debt instruments where the borrower is permitted to prepay the instrument at an amount that could be less than the unpaid principal and
interest owed. Such a prepayment
feature is often referred to as including potential ‘negative compensation’.
Under the then existing requirements of IFRS 9, a company would have measured a financial asset with negative compensation at FVTPL as the
‘negative compensation’ feature would have been viewed as introducing potential cash flows that were not solely payments of principal and interest.
However, to improve the usefulness of the information provided, in particular on the instrument’s effective interest rate and expected credit losses, the
IASB issued the amendments so that entities will now be able to measure some prepayable financial assets with negative compensation at
amortised cost.

Derivatives and
Embedded
Derivatives
53
Definition of a Derivative
'Underlying Initial Net Investment Future Settlement
• value changes in response to the change in a • requires: • settled at a future date

specified interest rate, financial instrument price, ‒ no initial net investment; or
commodity price, foreign exchange rate, index of
‒ initial net investment smaller than would
prices or rates, credit rating or credit index, or
be required for other types of contracts
other variable
that would be expected to have a similar
• exception for a non-financial variable that the
response to changes in market factors
variable is not specific to a party to the contract

Underlying – Examples
• An interest rate (e.g. LIBOR)
• A security price (e.g. the price of share of XYZ entity equity share listed on a regular market)
• A commodity price (e.g. price of a bushel of wheat)
• A foreign exchange rate (e.g. EURO/ USD spot rate)
• An index (e.g. a retail price index)
• Other variables (e.g. sales volume indices specifically created for settlement of derivatives)

Specific– Examples
Derivative Underlying Notional Amt Settlement Amount
Stock Options Market price of shares Number of shares ( Market price of at settlement- strike
price)*Number of shares
Currency Forward Currency Rate No. of currency units (Spot rate of settlement- Forward Rate)*No. of
Currency Units
Interest Rate Swap Interest Rate Amount in currency units Net settlement occurs periodically throughout the
contract term according to
= ( Current interest ate index - fixed rate
specified in contract)* Actual currency units
Fixed Payment 6-month LIBOR increase by 100 points Not specified Settlement amount based on payment provision
Contracts in contract

Embedded Derivative
Hybrid Instrument
Embedded
Derivative
Host Contract
Host Contract may be Debt , Equity, Executory Contract, Lease, Insurance
Embedded derivative may be Interest rate index, Commodity Index, Equity index

Embedded Derivative
Example
A Company with $ as its functional currency buys raw materials for use in production from a UK company that has as £ functional currency. The
transaction is denominated in €, not a functional currency of either party to the transaction, and so an embedded derivative has been included in the
purchase account.
There are two elements to the contracts
1. Contract to buy/ sell goods; and
2. Movement on the $/ € and £/ € exchange rates.
The contract to buy/sell goods is a host contract. The movement in exchange rates is the embedded derivative ?
Solution
A purchased convertible instrument would be an embedded derivative that is not separated because the host contract (debt asset) is within the scope of
IFRS 9.
If the host contract is not a financial instrument, the embedded contract is accounted for separately.

De-recognition
and Impairment
59
Asset Derecognition Model
3.Has the entity transferred the rights to the cash flows
asset?
1. Consolidate all
subsidiaries(including any No
SPEs)
No Continue to recognize
4.Has the entity assumed an obligation to pay the cash
the asset
flows from the assets that meets the pass-through criteria.
2 .Derecognition rules to be applied to Yes Yes

all or part of asset(group of similar
assets) Yes
5.Has the entity transferred substantially all risks and Derecognise the asset
rewards?
No No
Have the rights to the cash flows from Continue to recognize
the asset expired? 6.Has the entity retained substantially all risks and Yes the asset
rewards?
No
Yes No
7.Has the entity retained control of the asset? Derecognise the asset
Yes
Derecognise the asset
Continue to recognize the asset to the extent of the entity's
involvement

Asset Derecognition
Example
If Entity A has entered into an interest rate swap, where the counterparty obtains the right to interest cash flows but not the principal cash flows of the debt
instrument.
Whether derecognition principles should be applied to interest cash flows or principal payments or both.
Solution
Interest Cash Flows only as the contract is only w.r.t. interest cash flows

Liability Derecognition
General principle Modification/ exchange of financial

liability
Derecognise liability only on extinguishment i.e.
when obligation: Accounted for as an extinguishment if revised
- cancelled (legal release) terms are substantially different to original terms
- settled
- expires
- repurchased

Impairment of
Financial Assets
63
Credit Losses Increase as Credit Risk Increases
Deterioration in credit quality
Stage 1 Stage 2 Stage 3
Not deteriorated significantly deteriorated significantly in credit have objective evidence of

since initial recognition or have quality since initial recognition but impairment at the reporting date
Credit quality
low credit risk at reporting date that do not have objective evidence
of a credit loss event
Recognition of 12-month expected credit losses lifetime expected credit losses

expected credit when asset originated or lifetime expected credit losses when when credit losses are incurred or
losses purchased credit quality deteriorates asset is credit impaired
significantly
Interest based on gross carrying

Recognition of amount of asset Interest based on gross carrying Interest based on net carrying
interest amount of asset amount of asset
Performing Under-performing Non-performing
if the financial instrument is determined to have low credit risk at reporting date, it may be assumed that the credit risk on a financial
instrument has not increased significantly

The New Impairment Model
Is the asset credit impaired at initial recognition
Recognise changes in lifetime expected credit
losses
n
Is the asset a trade receivable / lease receivable, for which the lifetime expected credit
loss measurement has been elected
Recognize lifetime expected credit losses

Is the asset a trade receivable
Has there been a significant increase in credit risk since initial recognition
Recognise 12 months credit losses

Symmetrical Impairment Model
credit risk increased significantly

from initial recognition
12 month expected credit Lifetime expected credit

losses losses
credit risk reverses

Impairment – Determining significant
increases in credit risk
At each reporting date:
Assess whether credit risk has increased significantly since initial recognition
Compare risk of default occurring as at reporting date with that at initial Assume that credit risk has not increased significantly
recognition since initial recognition where low credit risk at reporting
date
• consider reasonable and supportable information that is available
without undue cost or effort
• no need to undertake exhaustive search for information

Example
Company A uses an internal credit rating system of 1 to 10, with 1 denoting the lowest credit risk and 10 denoting the highest credit risk.
A considers an increase of two rating grades to represent a significant increase in credit risk. It considers grades 3 and lower to be a "low credit risk.
At the reporting date A has two loans outstanding, as follows,
Grade at initial recognition Grade at reporting date
Loan A 2 5
Loan B 4 5
Examine whether there has been a significant increase in credit risk in respect of the loans ?

Solution
Significant credit risk increases? Recognize allowance equal to …..
Loan A Yes Lifetime expected credit losses
Loan B No 12-month expected credit losses
The measurement basis for the loss allowance is different for both the loans irrespective of the fact that both loans have the same grade at the reporting
date.

Rebuttable Presumption ‘Credit Risk has
Increased Significantly'
Rebuttable presumption that:
• credit risk has increased significantly where payments ≥ 30 days past due
• rebuttable only where:
‒ reasonable and supportable information demonstrates that even where payments ≥ 30 days past due, this does not represent a significant
increase in credit risk

Impairment – measuring expected credit
losses
Expected credit losses are a probability-weighted estimate of credit losses over instrument's expected life
• done by evaluating a range of possible outcomes

• may use practical expedients if consistent with
principles
• idea is not to use 'worst-case' (or 'best-case') scenarios
• e.g. calculating expected credit loss on trade

• must always reflect possibility of a credit loss occurring and a credit
receivables using a provision matrix
loss not occurring

Example Provision Matrix: Short term trade
receivables
Gupta & Company has a portfolio of trade receivables of $30,000 at the reporting date. None of the receivables includes a significant financing
component.
Company operates only in one geographic region, and has a large number of small clients.
Gupta & Company uses a provision matrix to determine the lifetime expected credit losses for the portfolio.
It is based on Company’s historical observed default rates, and is adjusted by a forward-looking estimate that includes the probability of a worsening
economic environment within the next year.
At each reporting date, Company updates the observed default history and forward-looking estimates.

Example Provision Matrix: Short term trade
receivables
On this basis, Gupta & Company uses the following provision matrix
Expected credit loss Trade Receivables $ Impairment allowance
Current 0.3% 15,000 45
1-30 days past due 1.6% 7,500 120
31-60 days past due 3.6% 4,000 144
61-90 days past due 6.6% 2,500 165
Over 90 days past due 10.6% 1,000 106
Total 30,000 580

Example: Debt instruments measured at
FVOCI
On 31 December 2019, Company Z purchases a debt instruments with a fair value of 1,000 and classifies it measured at FVOCI. The instrument is not
credit impaired. Z estimates 12-month expected credit losses for the instrument of 10.
On initial recognition of the instrument, Z makes the following entries
B/S Debt Security 1000
B/S Cash 1000
P/L Impairment Loss 10
OCI Loss allowance 10
At the end of the next reporting date, the fair value of the debt instrument decreases to 950. Z concludes that there has not been a significant increase in
credit risk since initial recognition and that 12-month expected credit losses on 31 Dec 2020 are 30.

Example: Debt instruments measured at
FVOCI
Accordingly Z makes the following entries at that date
B/S Debt Security 50
P/L Impairment Loss 20
OCI Loss allowance 30 ((balancing number)
NO loss allowance is recognized in the B/S in respect of debt instruments that are measured at FVOCI, because the carrying amount of these
assets is their fair value. However disclosures have to be provided about the loss allowance amount.

Hedge
Accounting
76
Hedge Accounting – Types of hedge
01 02 03
Fair value hedge Cash flow hedge Net investment hedge
Hedge of exposure to changes in fair value of a Hedge of exposure to variability in cash flows Hedge of a net investment in a foreign operation
recognised asset or liability; an unrecognised that is attributable to a particular risk associated (including a hedge of a monetary item that is
firm commitment; or an identified portion of any with a recognised asset or liability or a highly accounted for as part of the net investment), as
of the above two, that is attributable to a probable forecast transaction and could affect defined in IAS 21 - ‘The effect of changes in
particular risk. profit or loss. foreign exchange rates’ is accounted for
similarly to a cash flow hedge.
E.g. An entity with fixed rate debt converts the E.g. An entity with floating rate debt converts the
debt into a floating rate using an interest rate rate on the debt to a fixed rate using an interest
swap. rate swap.

What can be hedged
Highly probable forecast
transaction
Single item
Firm commitment
Group of similar items
(sharing the same risk)
Asset / Liability
Proportions of an item
Net investment in foreign

operations

Hedge Accounting: Risk management
strategy and objective
Risk management objective
Risk management strategy
• Established at a high level (e.g., entity) Applies at level of particular hedging

relationship
• Identifies risks (in general) and how entity responds to them
• Typically in place for longer period
• May include flexibility
• Often a formal policy document How a particular hedging instrument is

used to hedge a particular exposure
• Part of hedge documentation designated as the hedged item
Part of hedge documentation

Hedge Accounting: Hedged items
Entire item
Groups of items
Hedged item
Aggregated exposures
Components of an item
Proportion
Selected contractual cash

Risk components Nominal components
flows
Layer

Hedge Accounting: Hedging Instruments
Entire item
Hedging instrument
Partial designation
Proportion of the nominal

Exclude costs of hedging FX risk component*
amount
* only for non-derivatives

Hedge Accounting: Effectiveness
Assessment
Economic relationship
• Between hedged item and hedging instrument
• Systematic change (opposite direction) in response to same or economically related underlying
Credit risk does not dominate

• Credit risk does not frustrate economic relationship
• Credit risk can arise from hedging instrument and hedged item
Hedge ratio
• Consistent with actual ratio used by entity
• Different ratio only if accounting outcome would be inconsistent with purpose of hedge accounting

Examples on fair value and cash flow hedges
Illustration 17 and 18

Hedge Accounting
Example
On 1 January 2020, Kingale signed a contract to purchase a machine from a foreign supplier on 30 June 2020.
The purchase price of the machine, payable in cash on 30 June 2020, was 2 million shillings. On 1 January 2020, Kingale entered into a forward contract
to purchase 2 million shillings on 30 June 2020 for $1·1 million.
On 31 March 2020, a contract to buy 2 million shillings on 30 June 2020 would have required a payment of $1·2 million.
On 30 June 2020 the spot rate of exchange was 1·6 shillings = $1. The forward contract was settled by the other party making a payment of $150,000 to
Kingale on that date.
Kingale estimated that the useful life of the machine was five years from 30 June 2020, with no residual value.
The currency contract fully complies with the criteria and conditions for the use of cash flow hedge accounting as set out in IFRS 9.
Required:
Explain the accounting treatment for the years ended 31 March 2020 and 31 March 2021.

Hedge Accounting
Solution
Year ended 31 March 2021 $000
Statement of profit or loss and other comprehensive income
– in other comprehensive income
Gain on revaluation of effective hedging instrument 100
Statement of financial position
In current assets – derivative financial instrument 100
Year ended 31 March 2021
Statement of profit or loss and other comprehensive income
– profit and loss
Depreciation of property, plant and equipment -165
– in other comprehensive income
Gain on revaluation of effective hedging instrument 50
Reclassification of gain on effective hedging instrument -150

Hedge Accounting
Statement of financial position
Property, plant and equipment 935
Explanation and supporting calculations – year ended 31 March 2020
The property, plant and equipment is not recognised in the year ended 31 March 2020 because the contract to purchase is an executory one.
At 31 March 2020 the derivative will be shown on the statement of financial position under current assets at its fair value of $100,000. ($1.2 m - $1.1 m)
Explanation and supporting calculations – year ended 31 March 2021
Between 1 April 2020 and 30 June 2020 a further gain on revaluation of the derivative of $50,000 ($150,000 – $100,000) will be recognised in other
comprehensive income.
On 30 June 2020 the machine will be recognised in property, plant and equipment at cost. The initial amount recognised will be $1,250,000 (2 million ÷
1·6).
The financial asset will be removed from the statement of financial position of Kingale when the contract is settled on 30 June.

Hedge Accounting
The gain of $150,000 in other comprehensive income must be recognised in profit and loss as the cost of purchasing the property, plant and equipment is
recognised in profit and loss.
This is either done by adjusting the carrying amount of the asset at the date of recognition or by reclassifying the gain gradually as the property, plant and
equipment is depreciated.
Assuming the former depreciation for the current period is $165,000 (($1,250,000 – $150,000) × 1/5 × 9/12).
Assuming the former the closing balance in property, plant and equipment is $935,000 ($1,250,000 – $150,000 – $165,000).

Hedge Accounting
Example
Entity K has issued a 10 year floating–rate note, which pays interest quarterly at 3 month LIBOR. Entity K has entered into a basis swap under which it
receives 3 month LIBOR and pays 1 month LIBOR and designates it as a hedge of the changes in fair value of the debt attributable to interest rate
movements between the repricing dates of the note.
Solution
Yes. Entity K is permitted to designate the basis swap as a fair value hedge of the variable rate asset. The fair value hedging adjustment to the debt
attributable to the risk being hedged will be measured against an overnight rate in order that all of the change in fair value attributable to interest rate risk
is included. As a result, ineffectiveness may arise in the relationship.
Hedges of foreign currency exposure

An entity enters into a binding contract to purchase machinery for a fixed amount in foreign currency at a future date and hedges the amount in its
functional currency by entering into a forward foreign exchange contract.
The entity is hedging the risk of changes in the value of the contract to purchase machinery due to changes in foreign exchange rate.

Hedge Accounting: Disclosures
• Risk management strategy
• Effects of hedging on amount, timing and uncertainty of future cash flows
• Effects of hedge accounting on the primary financial statements
• Other disclosures for particular situations (dynamic strategies and credit risk hedging)

Interest Rate
Benchmark Reform
(Amendments to IFRS 9,
IAS 39 and IFRS 7)
90
Interest Rate Benchmark Reform-Issues &
Proposal
Highly probable requirement and prospective assessments of
Designating a component of an item as the hedged item
hedge effectiveness
• Where an entity currently designates IBOR cash flows, the replacement of • The changes amend the hedge accounting requirements in IFRS 9 and IAS
IBORs with new interest rate benchmarks raises questions over whether it 39 for hedges of the benchmark component of interest rate risk that is not
will be possible to make the assertion that those cash flows will still occur in contractually specified and that is affected by interest rate benchmark
a hedge of highly probable future cash flows, and whether the hedging reform.
relationship meets the requirements to be viewed as effective on a • Specifically, they state that an entity applies the requirement (that the
prospective basis. designated risk component or designated portion is separately identifiable)
only at the inception of the hedging relationship.
• The IASB therefore has provided exceptions for determining whether a
forecast transaction is highly probable or whether it’s no longer expected to
occur. Specifically, the amendments state that an entity should apply those
requirements assuming that the interest rate benchmark on which the
hedged cash flows are based is not altered as a result of interest rate
benchmark reform.

Interest Rate Benchmark Reform
Effective date and transition Number of entities affected Impact on affected entities
In acknowledgement of the speed with which ❑ Few ❑ Medium

interest rate benchmark reform is progressing, the • The amendments affect entities with hedging • These amendments provide urgent relief from the
amendments are effective for annual periods relationships directly affected by IBORs. effects of IBOR on hedge accounting. However,
beginning on or after 1 January 2020, with earlier they address only the hedge accounting issues
application permitted. They should be applied arising when IBORs are replaced with alternative
retrospectively, with early application permitted. risk free rates (RFR) so are known as the pre-
replacement issues.

Thank you for your attention
Any questions?

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Financial

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IAS 32 – Presentation of Financial Instruments

IFRS 9 - Financial Instruments – effective for periods beginning on or after 1 January

❑ Recognition and derecognition of all financial assets and financial liabilities

❑ Impairment of financial assets

❑ Criteria for hedge accounting

IFRS 7 – Disclosure of Financial Instruments

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Interest in Subsidiary, Associate and Joint venture (IFRS 10 and

Contracts for contingent consideration in business combinations

Employees rights and obligation (IAS 19)

Financial instruments, contracts and obligations under share-

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• an equity instrument of another entity

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• to deliver cash or other financial assets to another entity

• to exchange financial assets/ liabilities under potentially unfavourable conditions; or

(See further for examples)

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4 Interest in subsidiaries, associates and joint venture

5 Assets held for sale accounted for as per IFRS 5 No NA NA

6 Interest in subsidiaries, associates and joint venture Yes Yes Yes

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9 Construction contract receivables Yes Yes Yes

10 Finance Lease receivables Yes NA NA

11 Trade receivables Yes Yes Yes

12 Pre-payments - Goods and services No NA NA

13 Cash and cash equivalent Yes Yes Yes

14 Trade payables Yes Yes Yes

15 Accruals- goods and services Yes Yes Yes

16 Deferred Income (advance received) No NA NA

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in other words, contracts that are not liabilities

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Why does it matter?

Initial and subsequent

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Financial instrument is an equity instrument only if both criteria are met:

Does the entity have an unavoidable contractual obligation?

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• Obligation to pay cash • Discretion over cash payments (i.e. no obligation)

– Expectation of profits for the period

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Non-redeemable shares with discretionary dividends

Irredeemable preference shares with contractual dividends payable @4% p.a.

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• must meet the definition of equity

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Instrument Liability Component Equity Component

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• The entity incurs issue costs of INR 100,000.

How should ABC PLC classify the bond?

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1 Interest 120,000 1/1.09 110,092

2 Interest 120,000 1/1.09^2 101,002